Abstract

This thesis studies the impact of transaction costs on stocks prices and examine the impact of institutional investors and high frequency traders (HFTs) on market quality and transaction costs. It is comprised of three chapters.

Chapter 2 uses a clean and novel field experiment to study how stock prices of publicly listed companies respond to changes in transaction costs. Using the SEC's pilot program that increased the tick size for approximately 1,200 randomly chosen stocks, we find a decrease in market capitalization of $7 billion for stocks affected by the larger tick size relative to a control group. We find that the increase in the present value of transaction costs accounts for a small percentage of the price decrease. We study channels of price variation due to changes in expected returns: investor horizon, liquidity risk, and information risk. The evidence suggests that trading frictions affect the cost of capital.

Chapter 3 examines the effects of multimarket high-frequency trading (HFT) activity on liquidity co-movements across different markets. Multimarket trading by HFTs connects individual markets in a single network, which should induce stronger network-wide liquidity co-movements. We use the staggered introduction of an alternative trading platform, Chi-X, in European equity markets as our instrument for an exogenous increase in multimarket HFT activity. Consistent with our predictions, we find that liquidity co-movements within the aggregate network of European markets significantly increase after the introduction of Chi-X and even exceed liquidity co-movements within the home market. They are especially strong in down markets and for stocks with a higher intensity of HFT trading in the post-Chi-X period.

Chapter 4 studies optimality of trade execution by institutional trading desks. We document the presence of negative autocorrelation in intraday stock return and show that the temporary price pressure is larger at the beginning and the end of the day. Institutional trading volume exhibits similar intraday pattern. We relate the periodity of price pressure to trading desks' performance using a proprietary database of institutional investor trades. We find that execution quality is the worst at the end of the day yet institutional trading volume is also surprisingly high. Poorer performing brokers in terms of execution shortfall trade more in the last hour of the day, have a higher execution cost at the end of the day, and carry out less order splitting at the end of the day. Our findings suggest that intraday price pressure stems from end of the day clustering of under-performing trading desks strategies results in higher trading costs and poorer execution quality. A trading strategy exploiting this intraday predictability yields a monthly return of 16.11%. Our results have implications on the impact of broker selection and execution strategy on trading costs.